Question

A company has just paid a dividend of $ 2 per share, D₀=$ 2 . It is estimated that the company's dividend will grow at a rate of 15 % percent per year for the next 2 years, then the dividend will grow at a constant rate of 5 % thereafter. The company's stock has a beta equal to 1.4, the risk-free rate is 4.5 percent, and the market risk premium is 4 percent. What is your estimate of the stock's current price? Round your answer to two decimal places.

Answer 1

Required rate = risk free rate + beta (market risk premium)

Required rate = 4.5% + 1.4 (4%)

Required rate = 10.1%

Year 1 dividend = 2 * 1.15 = 2.3

Year 2 dividend = 2.3 * 1.15 = 2.645

Year 3 dividend = 2.645 * 1.05 = 2.77725

Value at year 2 = D3 / required rate - growth rate

Value at year 2 = 2.77725 / 0.101 - 0.05

Value at year 2 = 2.77725 / 0.051

Value at year 2 = 54.45588

Current price = 2.3 / (1 + 0.101)¹ + 2.645 / (1 + 0.101)² + 54.45588 / (1 + 0.101)²

Current price = 2.08901 + 2.181981 + 44.923144

Current price = $49.19